Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Municipal bond yields

Dear Dr. Don,
I have a Florida municipal bond that has decreased in value in the last 30 days. Will it keep decreasing at this same rate? It is AAA rated and insured.
Thanks,
Ed Erratic

Dear Ed,
The run-up in Treasury yields over the past month has affected the municipal bond market, too. While there's no change in the credit quality of your municipal bond, its price has fallen to remain competitive with other municipal bonds.

Keep in mind that when interest rates go up, bond prices go down and vice versa. The interest payments on a bond with a coupon are contractual. That's why bonds are called "fixed income" investments. It's the changes in the interest-rate environment that cause the price fluctuations.

When Treasury notes and bonds sold off, their yields went higher. Municipal bond yields had to follow changes in the Treasury market to be attractive to new purchasers, so municipal bonds sold off, too.

There's not a perfect correlation between U.S. Treasury yields and municipal yields. The yield spreads will fluctuate over time with economic conditions.

Barring an economic catastrophe your insured muni bond will pay its face value at maturity and its worth will continue to fluctuate between now and then based on the interest rate environment. Price volatility will decline as the bond approaches maturity, but the rate of any decline next month depends on the trend in Treasury yields and the spread relationship between Treasuries and muni's. Changes in the bond issuer's credit quality aren't irrelevant but on an insured municipal bond it's not as important as it would be with an uninsured muni.

Take a look at the composite bond yields on Bondsonline.com for an instant overview of the yield relationships between the different bond markets.

-- Posted: Aug. 15, 2003